Beyond Pangloss: Financial Sector Origins of Inefficient Economic Booms

61 Pages Posted: 12 Sep 2020

See all articles by Frederic Malherbe

Frederic Malherbe

University College London - Department of Economics

Michael McMahon

University of Oxford

Date Written: August 2020

Abstract

Government guarantees to banks are ubiquitous. We study an equilibrium model where, in the presence of such guarantees, the equilibrium allocation can be characterised as Panglossian: it corresponds to that of a deterministic economy where the best possible state always occurs. However, GDP is inefficiently high and expected consumption inefficiently low. Financial sophistication magnifies this distortion, taking the allocation beyond the Panglossian outcome (i.e. with even higher GDP and even lower expected consumption). We argue that this mechanism is empirically relevant for advanced economies and suggest that the Great Recession, partly, reversed a Great Distortion.

JEL Classification: E22, G28

Suggested Citation

Malherbe, Frederic and McMahon, Michael, Beyond Pangloss: Financial Sector Origins of Inefficient Economic Booms (August 2020). CEPR Discussion Paper No. DP15180, Available at SSRN: https://ssrn.com/abstract=3688128

Frederic Malherbe (Contact Author)

University College London - Department of Economics ( email )

Drayton House, 30 Gordon Street
30 Gordon Street
London, WC1H 0AX
United Kingdom

Michael McMahon

University of Oxford ( email )

Mansfield Road
Oxford, Oxfordshire OX1 4AU
United Kingdom

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